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1.8 million layoffs the cost of China's zombie factories

“This is not nail clipping. Instead, this is taking a knife to one’s own flesh.” — Chinese Premier Li Keqiang

Six weeks ago I wrote about zombie factories in China, over capacity, the power of illusion and how the full picture of the Chinese economy couldn’t be known.

Workers load coal onto railcars during a snowfall at a railway station on January 22, 2016 in Jiujiang, China. (ChinaFotoPress / GETTY IMAGES)

Healthy debate ensued with one reader in particular who felt the column was “another of those ‘trash China’ articles.”

We ended the discussion on good terms.

It’s instructive, in light of the commencement Saturday of China’s National People’s Congress, to revisit distortions in the Chinese economy. Some of the numbers cited in the previous column were culled from the European Chamber of Commerce in China, which produced, in 2009, a detailed report on overcapacity.

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In late February the chamber weighed in again with an update bearing the kind of executive overview designed to make a reader’s eyes pop. “Steel production has become completely untethered from real market demand, and is now more than double the combined production of the four leading producers,” the report noted, meaning Japan, India, the U.S. and Russia. Or, citing the National Bureau of Statistics and the U.S. Geological Survey, “in just two years — 2011 and 2012 — China produced as much cement as the U.S. did during the entire 20th century.”

The overcapacity problems had not diminished in the six year span between the two reports but had become even more pronounced. Economic restructuring appeared ever more elusive. And any government pledges to address the problem rang hollow, especially in light of a massive $586-billion industrial stimulus package announced in 2008 that spurred untenable borrowing by state-owned enterprises after the world economy had already headed into crisis.

Ballooning domestic capacity was mismatched against shrinking global demand, especially in old-world, or low-tech industries such as steel and cement. The obvious end result has been a dramatic increase in non-performing loans, which doubled in 2015 to $300 billion (U.S.).

The so-called zombie, or walking dead, factory is the visually arresting image to latch on to. Hobbled, debt-ridden operations kept alive in order to roll over unsustainable debt. A New York Times reporter wrote an eerie dispatch from Changzhi, in Shanxi Province, which he found littered with half dead cement factories. “If we ceased production, the losses would be crushing,” a manager explained to the Times. “We are working for the bank.”

True, the zombie factory is not exclusive to China, as my reader made clear. Think of an idled North American auto assembly plant, he wrote. But nothing matches the scale and scope of China’s trauma, with the added distortion that local governments were setting output targets and local officials were promoted or demoted based on GDP growth.

The government’s acknowledgment of the problem, and promises of structural reform, are not new: pledges to halt over-capacity date back years, with minor effect. At the time of last year’s Congress, Premier Li Keqiang emphasized how wrenching change will be. “Vested interests will be upset,” he said, before offering his more vivid wrist-slashing image. The future, he added, lies in entrepreneurship and innovation. In December Li said his country needed to “speed up the move to knock out backward industries and zombie firms.”

On Monday, the Chinese government made a move on that front, announcing that layoffs are coming for both steel and coal workers — 1.3 million in the coal industry and 500,000 in steel. (For context, China’s approximately 150,000 state owned enterprises employ 30 million people.) The country’s social security minister said that the laid off workers will be reallocated, though we don’t know what that means. Larger numbers were reported by Reuters, citing unnamed sources projecting layoffs of between five and six million workers. Reduction in coal production capacity is targeted at 500 million tonnes; 150 million tonnes in steel, with a completion date of 2020.

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That target date ties in with the government’s five-year economic plan, which runs to 2020 and will be finalized (read rubber stamped) this weekend. There will be lots of talk about growth in culture, and the aforementioned innovation, and green tech. All good stuff. Pollution spewing smokestack industries will be relegated to the pages of the past. Or at least that’s the promise.

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